Taxes may be inevitable, but you don't have to pay more than you are legally obligated to pay. The famous Gregory v. Helvering case, argued before the U.S. Supreme Court in 1934, established every taxpayer's right to reduce or avoid taxes altogether, as long as he does so through legal means. You might be able to reduce your income tax obligation, but the Internal Revenue Service won't do it for you. It will take diligence on your part.
When it comes to reducing your taxes, you must think like a Boy Scout and be prepared. Don't kid yourself by thinking you will remember all of your deductible expenses. Start preparing for your taxes at the beginning of the year. Keep a ledger and a tax file. It doesn't have to be complex. A simple spiral notebook will suffice to make notes of dates, amounts and circumstances for tax-deductible events or expenditures. Any time you spend money on a deductible expense, get a receipt and place it in your tax file. This is particularly important when you use cash, because you might not have any other paper trail to verify your expense.
Itemized vs. Standard Deduction
The IRS offers you two ways of taking deductions. You can either take the standard deduction or you can itemize your deductions. Most taxpayers take the standard deduction because it is far simpler to figure and it usually provides the greatest tax savings. If you paid a substantial amount in deductible expenses, such as mortgage interest, unreimbursed medical expenses, property taxes or investment losses during the year, you might be better off itemizing your deductions. The IRS recommends figuring your taxes using both methods. You can reduce your taxes by filing your tax return using the method that offers the lowest tax obligation.
Taxable Income Reduction
The IRS considers all income that is not specifically exempted by law from taxation to be taxable income. Your taxable income is reduced by the amount of your standard deduction or itemized deductions. You can further reduce your taxable income by contributing to a traditional individual retirement account. Some employers offer pre-tax cafeteria benefits options, such as health insurance and retirement plans. Electing to make your contributions with pre-tax dollars will reduce your taxable income. Your taxable income is also reduced by the number of exemptions you claim. You can claim an exemption for yourself and one for each of your dependents. If you are married and file a joint return you can claim an exemption for your spouse.
Tax credits are more valuable than tax deductions for reducing your tax obligation. A tax deduction reduces the amount of income that is subject to taxation. A tax credit provides a dollar-for-dollar reduction in the amount of tax you owe. You might be eligible for the Earned Income Credit, the Child and Dependent Care Credit, the First-Time Homebuyer Credit, or other tax credits. The amounts and types of tax credits that are available vary from year to year based on acts of Congress. If you are eligible for a tax credit but don't claim it, you paying taxes unnecessarily.
File and Pay On Time
File your income tax return by the due date, which is typically April 15 for the previous tax year unless there is a federal holiday or weekend involved. If you expect a tax refund, file your tax return early. The sooner you get your refund, the sooner you can put that money to work for you. If you have to pay, keep the amount you owe in an interest-bearing account and wait until closer to the due date before filing your return so your money can continue earn interest for as long as possible. If you are unable to file your return by the due date, request an automatic extension. As the term implies, the extension is automatic upon request, and it will give you an additional six months to file your tax return. This is important because there are significant tax penalties involved with filing your tax return late, and filing an extension request avoids those penalties. Your federal income taxes are due by April 15 even if you file an extension request. Pay your taxes on time to avoid additional penalties and interest.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.